Residents
Owners
The promise of passive income is what spurs property investors to own a rental property. However, time can impact the aesthetics and value of a property, resulting in wear and tear. Thus, maintenance or renovation is a must to bring back the beauty of your rental home.
If you want to cover the cost of your rental property purchase and maintenance, you can claim a deduction on your taxes through rental property depreciation. This way, you can compensate for expenses on maintenance or renovation. Here are things you must know about rental property depreciation.
What is Rental Property Depreciation?
Rental property owners should report the rent as income on their taxes. The costs of purchasing the property and maintaining it can be deducted from your taxes by filing a rental property depreciation. Remember that depreciation is not an assessment of the value of a rental home, but an allocation of expenses on its purchase and keep-up.
It is crucial when filing for depreciation to show the IRS the determinable useful life of the property before you can claim the tax deductions. Then, calculate the amount you have expended on the rental property over its useful life to reduce your taxes on your rental income.
Qualifications to Meet When Filing for Rental Depreciation
There are necessary conditions you must meet before you can claim tax deductions for a rental depreciation.
- You must be the owner of the rental property
- You generate income from using the rental property
- You should ascertain the property’s useful life (i.e., it should eventually be used up or worn out)
- The determinable useful life of the rental home should be longer than a year
How to Determine the Rental Property’s Useful Life
The General Depreciation System and the Alternative Depreciation System are two common ways to determine the useful life of a rental home. Here is a comparison of these two systems.
General Depreciation System
- 27.5 years is the recovery period for residential rental homes
- Shorter recovery periods
- A typical method that rolls out the deprecation of the rental home over its determinable useful period
Alternative Depreciation System
- The recovery period for residential rental properties is 30 to 40 years.
- Longer recovery periods than the GDS
- The owner can claim high levels of depreciation annually
When Does Rental Property Depreciation Start?
As the owner of a rental property, start deductions for depreciation as soon as you put the property in operation and make it suitable for rental.
For instance, you purchase a property on September 1. It takes you some time to prepare the house, and on November 1 it will be ready for rent. After that, you start advertising online and in local publications. Then, someone wants to rent the property and signs the lease, which begins on December 1.
Start depreciating the property on November 1 since it was when you put it ready for rent. You can continue the depreciation of your rental home until the total cost is deducted or until you retire it from service.
Calculating the Rental Depreciation
When calculating the depreciation of a rental home, it is crucial to figure out the cost basis by dividing its useful life under ADS or GDS. For instance, if the cost basis is 217,000 and you divide it by 27.5 years (the GDS useful life), then you will have $7,890.91 annually. You can also work with an accountant for assistance in calculating the rental depreciation.
Reporting Rental Depreciation to the IRS
You need to use different forms for reporting rental depreciation depending on certain circumstances, but it is common to report it on Schedule E of a 1040 tax form. Ask a financial advisor if you want to know the tax form you should use when filing rental depreciation.
Rental Property Depreciation Limit
Rental property owners must not exceed the $100,000 gross income limit and can claim tax deductions of up to $25,000.
Selling the Rental Property
Selling a rental property beyond its depreciated value will require you to pay a depreciation recapture tax. This tax can amount to 25% of the amount above the depreciation value that your rental home is sold.
What If I Do Not Claim Rental Depreciation?
If you own a rental property for the first time, it is easy to overlook this tax deduction. However, after filing your most recent tax return, you can claim your depreciation benefit by filling out Form 1040x along with additional documents. It is vital to claim your rental property depreciation because it will reduce the taxes you have to pay.
Takeaway
Rental property owners should take advantage of rental depreciation because it allows them to spread the expenses of purchasing a property and its maintenance over decades. Remember to seek the help of a certified tax accountant when filing your rental depreciation since tax laws can be complicated and may change periodically.
